Brian, I think that the way you worked it makes lots of sense and seems the most practical thing to do under the circumstances.
However, in the case book there is an EXACT situation (5.8.3E on page 38) that says the timeout should have been assessed to Team B and used, even though it was erroneously recognized. It reads like this:
"Play: The official erroneously grants Team B a time-out in a situation when Team B cannot have one. What happens now? Ruling: Team B is entitled to use the time-out since it was granted. The time-out once granted CANNOT be reovked and is charged to Team B. All privileges and rights permitted during a charged time-out are available to both teams."
My understanding according to NFHS rules is that once the whistle is blown in response to a time-out request (whether the request is legal or not), you "charge it and use it" even if the team was not legally entitled to it. Of course, the preventive remedy is to not blow the whistle in response to a timeout request that a team is not entitled to receive.
According to this rule, when your partner (who as trail and near the bench where the coach hollered timeout) blew the whistle and "stopped the game," then Team B should have been allowed the time-out. While it is an error, it is not a correctable error. Once the whistle is blown, you probably should just live with it.
I agree with both you and Smoke that, according to how you did work the situation, if the coach had repeated the timeout request during the dead ball period, you would then have been required to award the timeout.
Hey, sometimes it happens and when it does, you just do your very best in light of the circumstances. It sounds like the two of you did alright.
BTW, I believe in NCAA an erroneous timeout is handled differently (probably just like you worked it), in that it is not assessed, at least according to the "1999-2000 rules differences chart" listed in the NFHS rule book and the NCAA rule book.
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