Life-time free upgrade is just ridiculous, but:
Fact:
M&B fans were promised an expansion. Warband was initially announced as an expansion. Throughout most of its development, was discussed and advertised as an expansion. Even after its release, many sources still consider it an expansion, including most major game news sites.
Fact:
By industry standard, this is still what would be considered an expansion: based on the same engine, mostly recycled assets, basically the same gameplay. Yes, it offers many improvements, but it's all along the line of an expansion rather than replacement. Any of the recent Total War expansions easily dwarf the new content offered in Warband, for example.
Now, TW and Paradox are of course free to call it a proper sequel. But they've done a very bad job at communicating this to the M&B fans, who had been nothing but supportive, as well as the press. (Case in point: this forum is still labeled "Mount&Blade: Warband Expansion".) With all the signs and sources suggesting that it is strictly an expansion, a potential buyer cannot be reasonably expected to magically know that TW&Paradox are now calling it a sequel.
I say they deserve any backlash they incurr.