Are they really running WordPress version: 2.8.4?
If you look here at the database description for that rev, you’ll see there is no table ‘wp_categories’. It’s likely an outdated plugin during the view (which is why the admin level add categories is not effected).
I was starting to not believe you, having looked at the b2.php file in my copy of the 0.71 Gold release. I did find the aforementioned if-statement in the index.php. Might want to update the b2.php file, if you have not done so already or drop the file altogther.
Are there plans to allow $posts and $cat to work together so that you can display the $posts most recent entries in a single category? As it is, it seems $cat overrides $posts in the SQL call.