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.
* 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.