Mr Crofton has been cleared of five counts of racial discrimination against former head of personnel services Sam Yeboah.
Mr Crofton appealed against conclusions made by the 1998 employment tribunal which ordered him to personally pay out£59,000 in compensation, a record for personal payment, and the council a record£420,000.
Mr Justice Burton rejected the tribunal's ruling, which said: 'Mr Crofton did and does have a fixed mental impression that Africans, particularly West Africans, have a propensity to commit fraud.' It also said Mr Crofton had subjected Mr Yeboah to persistent false allegations of fraud.
Mr Justice Burton called the judgment 'perverse' and said it had 'no basis' in fact after seeing fresh evidence which included witness statements dis-allowed in the 1998 tribunal.
He said: 'The conclusion that the steps taken by Bernard Crofton, his criticisms of, and views and beliefs about Sam Yeboah - right or wrong - were indicative of racial discrimination are perverse and/or indicate an erroneous approach by the tribunal to the onus of proof.'
The judge suggested a re-hearing is unlikely in light of the 'very substantial compensation already received by Mr Yeboah'.
Mr Crofton, who now works as a housing consultant, said he felt 'absolutely vindicated'.
'The appeal has rejected the idea that my criticism had anything to do with Mr Yeboah's racial origin. It was about his failure to stop fraud against council taxpayers and the needy of Hackney,' he said.
'Ironically, they are the ones who have paid his compensation and the legal bills in this bizarre case.'
The marathon dispute began when Mr Crofton criticised Mr Yeboah for failing to do enough to tackle the appointment of staff with bogus qualifications who were involved in a multi-million pound housing fraud - many of whom had a West African background.
Mr Yeboah was represented by the Commission for Racial Equality which spent an estimated£0.5m on the case and considered the result a major coup in its fight for equality. But just weeks before the appeal ruling, the commission withdrew its legal representation for Mr Yeboah.
'We didn't legally represent him in this case because it wasn't going to materially alter the way the debate went,' said a spokesman, who added that, as litigation is still ongoing, it would be inappropriate for chairman Gurbux Singh to comment.
Hackney does not intend to appeal against the original ruling. Mr Yeboah was unavailable for comment.
-The Crofton Saga
1990: Hackney LBC's housing director Bernard Crofton begins an investigation into allegations the housing department is riddled with corruption.
Sam Yeboah, head of personnel, objects to an audit of staff and claims investigators have no right to inspect confidential files. The investigation finds evidence of illegal squatting and recruitment of staff with bogus applications.
1994: Mr Crofton says Mr Yeboah should apologise to the council because he 'put crooks into jobs'. Mr Crofton is later alleged to have included Mr Yeboah in a list of suspects sent to the Fraud Squad for investigation.
1995: Mr Crofton is sacked for racial discrimination against Mr Yeboah, but then reinstated by an appeals committee.
1996: The House of Commons' social security select committee praises Mr Crofton as an 'outstanding public servant' for rooting out£2m of corruption. Mr Yeboah resigns from the council.
Independent inquiry by Ian MacDonald QC accuses Mr Crofton of fostering an atmosphere where black staff are subjected to a witch-hunt. Mr MacDonald finds there are 'professional fraudsters' within the council, but no evidence of a major conspiracy to defraud the council.
Sixteen Labour councillors resign from the party over a series of issues including the treatment of Mr Crofton, who they support.
1997: Mr Crofton takes early retirement from the council.
1998: Mr Crofton is found guilty on five counts of race discrimination at the end of a 104-day hearing. He is ordered to pay record damages of£45,000 plus interest of£14,000 by an industrial tribunal for racial discrimination against Mr Yeboah. The highest previous award against an individual was£1,000.
Hackney agrees to pay a total of£420,000 in a settlement to Mr Yeboah - the biggest ever in a race discrimination case.
2001: Mr Crofton's appeal against the ruling is heard, Hackney does not appeal. The CRE withdraws legal support for Mr Yeboah.
Employment appeal tribunal quashes the tribunal ruling which it describes as 'perverse'.