Hey mate,
Great question! It'd be helpful if you could share the title of the course. Some courses are pretty useful to have - so retaking it could help. That said, the reason behind the grade makes perfect sense. You could explain it away in an application if it came down to that. You don't want to go the route where you just don't report it. If you get in, you'll need to provide an official version and that will have the grade which will lead to complications. And there isn't something here that needs to be hidden. The best option would be to contact the school and see if they'll just take it off the record. If they don't, and you retake it, you can explain the previous grade in an optional essay easily. If you don't retake it either, then the optional essay is still the place to provide context.
Your situation isn't common but that doesn't mean it's any less credible!
Bhavik