I think you handled a difficult situation in a proper manner. You have sole discretion on whether or not someone can use your trademarked name.
Google has an automated process for doing this very same thing. I cannot use the keywords, playboy, hilton, hustler, kragen, 7-11, etc because their automated system knows these words. You can have your trademarks added... Google for how ;)
I applaud that you paid him since this wasn't spelled out in your terms of service. Some programs allow this sort of advertising and have sites like, "BigTitsBabes.com" and therefor the affiliate is better able to capture alternates like "big tits hotties" or "big boobs babes" and send them traffic they otherwise would not have received. Your case is unique since your brand name isn't often associated with sex outside of its full two word term.
I have seen companies vary their response to such advertising on a site to site basis. Perhaps they have something like Anilos which is a made up term for MILF, and then Nubiles which is already an established term defining barely legal teens in the industry. One they go balls to the wall to protect and the other they realize keywords like "nubile pussy" "nubile teens" "hot nubiles" etc could be beneficial for them to have affiliate capture.
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