Looks like a one or a combination of things could have caused this:

-The metal used for the dropout is inferior and it finally gave up due to the hundreds of times wheels have been tightened and loosen on the bike.
-The lock nuts on the hub you are using are a little smaller than normal and caused the metal to "cave in" and you fubar'ed your dropout.
-The dropout was already flared a bit and you took it over the top.

I've seen this happen every now and then at work but with increased frequency over the last few years. Ride it till you kill it or get a new frame.
One thing you could try is replace the locknut with a larger one so it grabs onto the frame better but your solution will probably work the best.
Poor bike....