Demon Internet faces a legal bill of around £500,000 after settling its long-running libel case about malicious messages posted to its newsgroup servers.

In an out of court settlement, physicist Dr Laurence Godfrey will be paid damages and costs by Demon. Godfrey claimed he had asked Demon to remove defamatory newsgroup postings from its servers which were forged so as to appear posted by him.

Demon refused to remove the postings - on the soc.culture.thai newsgroup - described by Godfrey's lawyers as "squalid, obscene and defamatory". The ISP must pay £15,000 damages plus legal costs, estimated at £230,000. Including its own costs, Demon's bill is likely to approach £500,000.

The case, settled just four days before a jury trail was due to begin, hinged on whether Demon could be treated as publisher of material on a newsgroup it hosted.

In a statement, Thus, Demon's parent company, said: "Thus remains convinced that the law has not kept pace with the development of the internet and will work with our colleagues in the industry to lobby for modernisation of the law."

"Thus will press the government for recognition that ISPs should not be liable for the millions of items carried on the internet every day," the statement added.

Dai Davis, head of the IT Group at law firm Nabarro Nathanson, criticised the law and said ISPs are not treated any differently from retailers. "If ISPs have effective control of people using the system, then they have no special defence," he said.

Davis said that because no formal ruling was made, the case does not set a legal precedent even though further similar cases might follow.

"Demon settled because it was frightened to go into court in front of a jury," said Davis. He added that Demon would not be able to advance a defence of innocent dissemination.

Other legal experts said that forthcoming European law could affect this.

Mike Pullen, a partner at solicitors Dibb Lupton Alsop, said: "Under the European Union's draft ecommerce directive, if an ISP doesn't know about libellous content, it will not be liable. If an ISP does have knowledge about defamatory content, it can be liable."

The case creates a dilemma for ISPs because if they screen submissions or suspend websites, which would in any case be technically difficult, they could inflame the debate over freedom of expression or damage internet-based businesses.