That's the warranty terms. This is an out of warranty iPhone so the warranty terms no longer apply. The correct terms are Apple's out of warranty replacement terms, which states devices that fail because of an unauthorized modification are not eligible. Technically, his device failed from an accident on the original screen, not because of his repair. He doesn't have the original screen, so I think the point is moot, but I say that putting the original one back on and asking for a repair is not fraud. It would be if he lied about repairing it, but asking is not against the law. They can just deny him a repair if they want, they're not required to do it.
Abuse isn't covered by an "out of warranty repair", and yes, OOW replacements are governed by the same T&Cs (it's still a warranty repair, just a chargeable warranty repair). You sign the same paperwork either way.
And trust me, modified phones are considered to be beyond economical repair (from Apple's point of view - if you had a smashed screen, the phone needs a new screen - if you've been mucking around in there, how are they to know what other damage you've done while you're in there). If you don't believe me, google "iPhone BER".
Also, FYI - there is a liquid contact indicator on the inside of the iPhone 4, on the middle MLB screw next to the battery. To open the phone and replace the screen, this will have been removed. If they open the phone, they will see this is gone, and will refuse service. Modified phones are unserviceable under any circumstances. You can never "qualify" as you put it after you've opened the phone. Other people might tell you what you want to hear, but this is the truth, whether you choose to believe it or not.
From my experience, it's quite easy to spot when an iPhone 4 has had its LCD replaced, since it's damn near impossible to line it up perfectly, and the proximity sensors have different covering on most "OEM" parts you get on eBay, etc.
service cannot be performed because the serial number has been altered, defaced or removed or the product has failed due to accident, abuse, liquid spill or submersion, neglect, misuse (including faulty installation, repair, or maintenance by anyone other than Apple or an Apple Authorized Service Provider), unauthorized modification, extreme environment (including extreme temperature or humidity), extreme physical or electrical stress or interference, fluctuation or surges of electrical power, lightning, static electricity, fire, acts of God or other external causes (“Service Exclusions”).
If you've taken the phone apart, and it's failed, then how do you know that you haven't caused the damage. It's not fair for you to assume that you haven't caused said damage, therefore this clause will apply. You will not find a genius in the land who will swap an iPhone you've opened.