The instructor is a beloved seasoned leader who is falling upon his culture's behavior in these situations. He believes confrontation creates more bad than good. He prefers to avoid conflict and find other ways to resolvable the conflict. A soft spoken man, and gentle disposition, it is out of character for him not to use great patience and tolerance to the end.
People in the class are upset and really are not prepared to handle this situation and they are seeking help.
This is your dojo. What do you want it to be? I am suspicious of any martial arts culture where the students are afraid to stand up for themselves. I was the sempai at my dojo at 4th kyu simply by virtue of the fact that we are a new dojo, only 2 years old, and I was with our Sensei from the beginning. Then a nidan moved to the area and I no longer have the title. Of course, even though I don't have the title, why would I change my behavior. I still help Sensei with anything he needs assistance with, he still relies on me to be a 'safe' training partner for brand new students, and I take personal responsibility for the culture of our dojo. We aren't extremely formal, so I make sure all of our students know proper etiquette for when they visit other schools, but I am also the first person to start laughing with Sensei accidentally says something that could be taken the wrong way. I don't think I have ever attended a class where we didn't laugh, and that part of training is just as important for me as any other aspect. And if the nidan that moved to our school was rude or disrespectful in any way to my Sensei, I would immediately have a discussion with him.
Just because Aikido works without 'fighting' doesn't mean it works by allowing people to do whatever they want while you wring your hands on the sideline. "I saw that you chose to do the technique differently than what was demonstrated, would you please explain why?" might be a good way to begin. You clearly feel that this person is attacking the culture and attitude of your dojo. Are you going to stand in front of him and allow him to hit you, or are you going to get out of the way of the attack and take control of the situation?
This sounds like an excellent opportunity to use Aikido. Not physically, but mentally. Every student who attends class is responsible for the attitude and culture of the dojo.