This is what happened;
An Oyster Penalty Fare is basically a non-refunded entry charge. I started the day with £5.25 credit. The card is supposed to cap at £5 and essentially becomes a 1 Day Travelcard. A penalty fare disables any cap for the day.
I started at Brixton at 10:05, touched out at King's Cross, where the barrier indicated the correct amount was deducted. I walked straight to St Pancras (OSI table states 40mins break permitted) and touched in, no problem. When I attemted to touch out at Hendon, the reader read "Enter" when it should have said exit, taken off more credit and left me with £1.65 or something.
I tried to get on a bus but the card had deducted a £4.20 entry fee at Hendon, so it was in arrears. I went to the nearest tube station, Burnt Oak and had the £4.20 refunded on the FasTIS+ machine. Although I now had £1.65 credit, the cap had been disabled. I made another journey which put the card into arrears.
So basically, I've undertaken a reasonably journey, been unfairly penalised by the card and the £5 I allocated to a 1 Day Travelcard on the Oyster had gone down the drain. I went to a different ticket office to get this sorted out, but they insisted they couldn't do anything and pointed me to the Oyster helpline. I rang them, but they do not receive journey data for a given day until midnight on the following day, so there was nothing they could do either.
I told the ticket office clerk that I had no money and banked on that £5 to get me around as much as I needed. I essentially made out that I was stranded, but they did sod all to help. The clerk recognised that I was not at fault, as I had a receipt showing my journey history for the day and the dodgy action at Hendon, but there was nothing they could do. In the end I gave up and put another £5 on the card.
The following day, I rang the helpline who gave me £9.xx to claim at a station of my choice, then I received the above email from TfL. That was all very nice, but I had £5 on the day and expected unlimited travel from that, which I was not given and was not rectified on the day. The least they could have done was print me a paper travelcard once they saw I was not at fault

.