Looking at the photo, I'm guessing the linoleum on that floor might have been put down 30 - 40 years ago. The orangey-looking decor suggests late 1960's or early 1970's. Maybe in those days laws governing fitouts were different. If city council is applying its current laws retrospectively, that in itself could be illegal and the lady may have a case against the bureaucrats. You can't say that a particular building law dated such-and-such date must be applied to anything done before that date otherwise everybody would be forced to tear their houses down and replace them with tepees or forest or whatever existed in California before the Spanish arrived!

What about the neighbours? Have they complained about any noises or other problems arising from the conversion?

Also I should think any conversion that doesn't alter the exterior appearance of the house as seen from the street would not need city council approval but I live in Australia where this law applies in some towns and cities.