Unite-backed Karie Murphy has been reinstated to the party but said she was withdrawing from the race for the Falkirk seat for the sake of “reconciliation and unity”.
The dispute sparked a furious row between Ed Miliband and union leaders, with Unite firmly denying any wrongdoing.
A Labour spokesman said “key evidence” had been withdrawn from the inquiry, believed to relate to claims people were signed up as party members without their knowledge in a bid to stuff the constituency with Unite supporters. “Karie Murphy and (constituency party chairman) Stevie Deans, who were suspended, will now be reinstated as they have not been guilty of any wrongdoing,” he said.
“No organisation or individual has been found to have breached the rules as they stood at the time.
“The general secretary has determined that given these circumstances Scottish Labour should move to select its candidate for Falkirk. These steps will enable Labour in Falkirk without further delay to choose a candidate and prepare for the general election.”
The pair were suspended and the Falkirk constituency party put into “special measures” after an internal report – not yet published – found concerns over the process of selecting a candidate for the 2015 general election.
The party referred the matter to the police and handed over documents but Police Scotland ruled in July that there were “insufficient grounds” for a criminal investigation.
It was the ensuing bitter public dispute between Mr Miliband and Unite general secretary Len McCluskey that pushed the Opposition leader to propose reforms to Labour’s historic links with the trade unions.
Tom Watson – for whom Ms Murphy worked – quit as the party’s general election co-ordinator at the height of the dispute.
In a statement released by Unite, Ms Murphy said she had been left “shocked and saddened” by the affair and had always acted in the interests of the party. But she said her continued presence in the Falkirk contest would “detract” from the work of selecting a good candidate.
“As an activist of 25 years, I was honoured to be persuaded to stand as a local MP, but there is only one decision to be made in the interest of progression,” she said.