I think Mike is correct. My reasoning by analogy follows.
There's a game called Skedaddle, and a Usenet group, rec.players.skedaddle. A well-known player, Mike, offers a $5000 challenge for a feat, called the four-froot-hoot, which he believes is simply impossible to achieve.
A fellow skedaddling enthusiast, Patrick, takes him up on the challenge, some baseline terms are negotiated, and Patrick presents his putative four-froot-hoot. Some might say it meet the terms of the challenge.
Mike objects, he says "you're a rat, Pat! look at the FAQ, Jack, that's not even skedaddle" and indeed, the F.A.Q. of rec.players.skedaddle does indeed state in plain language, that it ain't even skedaddle so it can't be a four-froot-hoot.
You make a bet in the club, you play by the club rules.
But the challenge wasn't for performing four-froot-hoot, the challenge was described in text and adhered to. Mike thought he was describing four-froot-hoot, but accidentally only made the challenge about four-froot. The club rules even described why four-froot was not an interesting challenge unless it were four-froot-hoot, which makes it doubly on Mike to issue the challenge for four-froot-hoot and not just four-froot, yet he flubbed it.
The "it ain't even skedaddle" aspect is just incorrect. Compression is a term of art, and it is very general. Saying that "hiding" things in the filesystem is cheating is no different than saying that using the previous frame to reduce the size of the following frame in a video compressor is cheating. Yes, you do have to be careful of exactly what your inputs are, but there is great value in taking advantage of additional forms of input even if they might be initially unexpected.
Besides, Mike's smugness deserves some comeuppance.
This is really how I see it too. If this spirit was really so important to the bet (and not just vaguely implied) it should have been stated clearly. Friendly ribbing over "you won by rules but not in spirit" is one thing when it's a free wager between buddies but not with real money on the line. Falling back on a position of spirit and intent trumping hard written rules in text in real money wagers basically guarantees that the banker has no real incentive to rule fairly on a win that can cost him money if he can get away with the loss of reputation- he can always weasel out of it one way or another by acting in bad faith and engaging in pedantry during the judging. No one would ever take up someone on a bet if they could turn around last second and say, well you didn't mind-read the additional rules and stipulations I'm adding on now after the fact to our original written agreement so in actuality you lost.
Additionally Mike's behavior during the exchange makes him feel all the more untrustworthy. His condescension, playing the fool and intentionally misinterpreting the test to "win", remarks made that seem specifically placed to needle and aggravate Pat knowing there's no way to force him to pay up, and threats of accusations of fraud were a show of really poor character. At the least it would've been more of a class act (even if he never paid out) to admit that Pat outplayed him due to naivety and a self inflated sense of cleverness on Mike's part, to admit that he is not familiar with betting culture and got in over his head.