Just to give an update, just fired my 3GS up for an update today, had same issue, phoned Apple support, they put me through to a senior tech straight away when I said the battery had swollen and pushed screen out.
To cut a long story short, tried to get me to device replace for £126 (GBP, so c.$180 USD) - very quickly said they would replace the DEVICE under a "battery replacement" scheme and charge me £62 (so c.$90 USD)
I did think about buying my own battery for £10-£20, but I think the the phone is pretty shot from being forced open from the inside so figured a factory refurb (new casing, camera lens etc) was worth it...
Still a little bitter though as my 1st Gen Nano had battery problems too, and they EVENTUALLY replaced all those free under a product recall...
Note also, towards the end of the call (after I had emailed the photos over to tech, and he called me back) he really wasn't keen when I was suggesting I turn the phone back on and just charge it to see what happens.....
Perhaps could have held out for more, but figure c.10% of cost for a factory replacement after 3 years isn't too bad,