I have to jump in on this one.
As a former tour director, I have had my share of grumps.
The general policy with most tour companies in regards to grumps is let the tour director deal with it. If it is not an isolated incident, the tour director needs to inform the tour company. If it gets out of control, and is disruptive to the other passengers, the tour company will usually call the passenger to see if there is a problem and if there is anything they can do. They will usually, very subtly, let grump know their behavior is disruptive and ask if they would be happier if they were flown home. If that doesn't work, the tour director will discuss the situation with the tour company and at the last resort the passenger will be removed.
This is very rarely done and part of our training is how to handle the grumpy passenger. I have never had to put anyone off a tour but I know tour directors who have. (And yes, tour directors do trade stories about "key" passengers--and not just the grumps.)
In most cases, that grumpy passenger, is not necessarily a grumpy person at home. But take them out of their comfort zone, change their schedule, keep them more active than they may be used to, fatigue, extremes in temperature/weather, amongst other things, and that can turn a nice person into a grump.
However the person described here is a fluke and rarely seen. The tour company should have backed up the tour director more and taken action.
One note....a small tour with only five people is different than one of 20+. It is much more intimate and the grump will stand out more.
The mistake the tour director made was, as you said, bending over backwards to placate this person. The TD then gave power to the grump. What he should have done was taken the passenger aside and explained that changes could not be made to make this one person happy as that is not what the others are expecting. Then ask the passenger if they are so miserable would they be happier if he helped the passenger go home early. That usually shakes them up enough because the subtle hint is "if you keep this up, you may be going home early."