This has finally been clarified by the Marketplace team as the most current, up to date, lore on the subject of free app updates - they're free, they don't count towards your 5 free submissions, even if they fail. Here's the word for word story straight from a Marketplace PM:

 

Paid Developer (USD$99):

1.     Unlimited number of paid applications.   You cannot change the price on a paid app to be free.

2.     Updates to paid apps that have been published are no charge.

3.     5 submission credits for free apps

4.     Updates to free apps that have been published are no charge.

 

DreamSpark (free):

1.     Unlimited number of paid applications.   You cannot change the price on a paid app to be free.

2.     Updates to paid apps that have been published are no charge.

3.     5 submission credits for free apps

4.     Updates to free apps that have been published are no charge.

 

* the failed updates for free apps are not  accounted against the developer quota

 

What do I do if I get charged for an update to a free app?

Submit a support request via the portal and you should get a response within 24 hours. Feel free to reference this blog post if needed.