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He knew he was in an interview for sure, however the terms have changes as soon as the lead developer asked him to code in the current application in order to test his skills.

Lets put this way, you are interviewing for a Car Sales position, you get to the my store and I ask you: Hey, today you gonna spend the day selling cars, it will be our test, and then you sell as many cars as you can for free.

Do you still consider this, part of the interview? Keep in mind that you are bringing profit to my store.

It is common practice when hiring a developer to pay them for time spent programming if it's any significant amount. I've never heard of paying for all the time spent in the interview, or for time spent if it's just something small and simple to get a quick feel for skill. But if they're asking for more than an hour or two or if they're asking for new features added to their existing code base, it's completely fair to ask for compensation.

When you call it an interview, but are in fact using it as a bit of free temp day labor without paying for the work accomplished.