Azza - Loved the story but with all due respect I think you may have let yourself off a little too easy. That said, I'm not a DM and can't say for sure what Id have done under the same circumstances but heres my view.
Three things seemed clear to me from your post:
First, Mr. 100DWI believed he was acting appropriately - as frightening as that may seem.
Second, you were convinced that he was incompetent and as such putting the students lives at risk.
Third, that despite the warning signs and specific policy violations you made a conscious decision to continue anyway. And, that that decision was based primarily on not jeopardizing your own Instructor aspirations and possibly the reputation of the dive shop.
Perhaps you should have called the dive on the shore. Alls well that ends well but suppose that something had gone horribly wrong? A jury might see you as a would be hero, or maybe just an accomplice.