The decision by the court of appeal was described by lawyers representing child abuse victims as "a blow at the church's culture of secrecy and denial" that would embolden other victims to come forward.
Governors at Preston Catholic college had argued that the claim by Patrick Raggett, 52, came outside the legal time limit.
Richard Scorer, an officer of the Association of Child Abuse Lawyers, said: "The church refused to believe Mr Raggett's account of the abuse and tried to have his claim struck out on technical grounds to do with time limits. The church claims to be facing up to child abuse amongst priests. If that is the case, it needs to stop trying to use the legal system to suppress evidence of abuse – it needs to listen to victims, learn from them, compensate them fairly and cleanse itself so that this shocking abuse does not occur in future."
Raggett alleges that, while he was naked, Father Michael Spencer – who taught at the school and died in 2000 aged 76 – measured him "to chart his growth", filmed him performing exercises, photographed him and touched him inappropriately.
In earlier court appearances, Raggett said the ordeal had severely affected his personal relationships and his career as a City lawyer.
He had suffered years of under-achievement at work, a failed marriage, binge-drinking and a breakdown.
The £5m he is seeking includes past and future loss of earnings.
SIC: TGUK
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