I think what really happened here is that someone at the Libyan domain authority decided they wanted the name and made up a story in order to seize it. I've heard of other cases of .ly names being confiscated, and for this reason we advise YC startups not to depend on them.
Does this not apply to all ccTLDs though? My understanding was that the majority of ccTLDs are controlled in a way that they are able to easily "reclaim" any domain they want at any time without breaking any "rules"...
So when you buy a .ME domain, you are subject to the relevant law and regulation of Montenegro, for .CO in Colombia, for .LY in Libya and so forth. If those countries elect to allow registrations outside their borders, that is their choice, but there is no external regulation on how they do that. They are accountable internally to the local Internet community of the country, and the local laws.
ICANN, on the other hand, is responsible for regulating many aspects for generic top-level domains (currently TLDs with 3 or more characters, such as .COM, .NET, .INFO).