You say: "They followed up today to thank me for doing it, but also indicated that they were putting a hold on my account anyway. As a result, I am not going to be able to register for my final quarter and have been de facto expelled at the end of this quarter."
Is it possible that some tiresome UW admin person has put your account on hold while this is being sorted out, but they haven't connected the dots that you now won't be able to register? Is the "de facto expulsion" an unintended consequence rather than a deliberate punishment?
And then perhaps this person is trying to say, hey, there's a way we could keep your project going if it's an official project, but we don't have budget for it. Let's discuss if that would work for you. And perhaps this was intended to be a suggestion for a positive outcome, rather than an IP-grabbing maneuver.
And when you say, "it was implied that they would then remove the hold, allowing me to graduate." I totally get that it feels that way, but is it possible that such an aggressive implication wasn't intended?
This might be wishful thinking on my part. It just seems so hard to believe that anything you've done comes remotely close to actual expulsion, and this idea that you'd be forced to work to graduate seems like a total head-scratcher that wouldn't stand up to any scrutiny. I'm hoping that this is just a poorly-handled, poorly-worded communication from this department.