The 20-year-old singer's representatives were said to have been contacted two months ago about the clip - which was made public this weekend and sees the 'Believe' singer use the word "n****r" five times - by a lawyer representing a guy who worked on his video projects.
The man was said to be in possession of the heartthrob's personal hard drive, saw the video and swiped it, before asking for $1 million in exchange for not making the footage public, TMZ.com reports.
Justin's team refused to pay out, even when the figure was dropped to $800,000 and then to $500,000 because they reportedly felt the footage wouldn't be very damaging to his career as he was so young at the time.
After the video was exposed, Justin - who is believed to be vacationing in Mexico - apologised for the inappropriate joke about black people and he claimed he "didn't realise at the time that it wasn't funny".
This comes at the same time that a shocking new video emerged where Justin reportedly joked about killing black people and joining the Ku Klux Klan.
The new footage sees him alter the lyrics of his 2009 song 'One Less Lonely Girl' by singing, 'One less lonely n****r', before he cracks a joke about joining the Ku Klux Klan - a racist hate group founded in the deep south of the United States.