Ok.
After spending about 40-50 minutes at the Apple store Genius bar in Chatswood Chase, I still couldn't resolve the issue. It was determined that Bluetooth was working fine (as we tested out on his personal iPhone 4S also) but could not gain access to the phones network, even though on both phones (mine and his) we recieved the Hotspot activated blue bar display. We tried deleting an re-pairing the devices to the point where we started getting messages that "Pairing was unsuccessfull", changed Bluetooth settings to PAN, withing Bluetooth Prefs: makesure Protocol set to RS-32 and Service to Wireless iAP, created a new login on the laptop, but still NO LUCK.
Odly, though, the very first time we set it up it worked! then we tried again to make sure, and after repeating the process all luck gone. We tried deleting all bluetooth and wifi prefs, (took a while to figure out where they were as they're in a different folder structure since updating to Lion), connecting via USB wasn't working either.
The best (and only) advice given was I would have to back up my entire HD and perform a clean install of OSX Snow Leapard, thus erasing my HD and starting over! Then I'd have to re-install Lion (which was downloaded, I better not have to pay for it again).
To my surprise, as I type this, I open up my MBP on my desk next to me at work, and go through the process yet again to make sure I remember things... VOILA!! It's working! ***! to make sure I disconnect and re-connect... so far so good, I am soooo confused, as I haven't done anything differently from my visit to the Genius Bar 3 days ago.