I agree that if this is what it sounds like, then you should definitely pursue some actions with the school. But, before you do that, I'm a little concerned that this is based soley on the word of a 7 year old. Not that I would think a child would lie, but what if they just misunderstood what was said? Before you do anything I think you need to follow-up with the school and get their side of the story. If nothing else, so demonstrate to everyone that you shouldn't jump to conclusions about anyone or any situation.
Now, if this plays out, then I would definitely move forward with alternate plans for your child and seeking some sort of formal resolution from the school. Though I'm not sure that a lawsuit is the right answer or would actually go anywhere.