My basic question is 'did I break my buddy's brake or did it arrive broken? Here is what happened:

A friend of mine asked if I could replace his disk brake pads. I said I had only done it a few times and it had been a while, but I said I could do it. He arrived having already removed the old pads from the front brake (worn completely down to the metal -- original pads and bike is at least 5 yrs old). I immediately noticed that where the adjuster knob on interior side had a metal tab in the center, the one on the exterior side did not, just an empty rectangular cavity where once protruded the tab. This I thought odd (see picture of red knob with silver tab in middle)

Upon turning the exterior knob to see if the mechanism was functioning correctly despite missing tab, the aluminum disk on the inside of the brake that moves in and out to adjust pad position when the knob is turned popped out of place. After partially disassembling the brake to investigate, it seemed to me that the metal disk that had popped out of place from inside the brake and the metal tab missing from the center of the knob on the outside were in fact once all one piece of aluminum -- i.e red knob engages tab then turning knob moves disk in and out . My theory is that the tab had gotten sheared off from excessive turning over the years, thus resulting in aluminum disk popping out of place. Is my theory about shearing correct? If so, this shearing definitely occurred before arrival in my garage since I turned the knob only a few clicks before things fell apart. It seems my friend needs a new brake. What are thoughts among readers more expert with disk brakes than I as to whether perhaps I somehow am responsible for damaging the brake?

assuming the outboard piston popped out which is common, unscrew the adjuster all the way then push the piston back in and it will click in to place.

I think reptilezs may have said basically the same thing as this but in far fewer words, but here's a section from the Avid tech manual that may be helpful in sorting out your problem:

"The most common issue with the BB7 is that the
outboard pressure foot can become dislodged if
the outboard adjustment knob is turned too far
clockwise without the rotor in the caliper (wheel
off or caliper removed). The brake is not broken,
nor does it require disassembly to replace the
pressure foot. To replace the pressure foot, turn
the outboard adjuster knob counter-clockwise
until it stops. If the knob doesn’t stop, then the
foot screw (the end of which can be seen in the
center of the knob) has become disengaged
from the knob and possibly from the threads
inside the drive cam. In this case, remove the
knob, then using a pair of small needle-nosed
pliers or a schrader valve tool, turn the the foot
screw all the way back out until it stops. Now
the pressure foot can be replaced. Relocate the
pressure foot into the bore, then give it a firm
push in the center. It will click back into place.
If you removed the knob, replace it and you’re
done!"

This is exactly the issue. Thanks

DOS: When you get the caliper repaired, be sure to put the spring that should come with new pads in, to help push the pads back when the brake lever is released. On adjustment, Avid says to loosen the caliper mounting bolts, then turn the inner adjusting screw and outer adjusting screw until the rotor is 'pinched' between the pads, with 1/3 of the space between rotor and caliper on the inside, 2/3 space to the outside. BB7's are 'single piston'--meaning that only the outer pad moves when lever is pulled. the 1/3-2/3 spacing helps keep rotor 'warping' to a minimum. After tightening the mounting screws, back inner and outer adjustments until the pads JUST clear the rotor. Now you should be good to go.

I successfully reassembled my buddy's brake thanks to guidance above. Thanks everyone for the help. Only issue now is that the rotor isn't true so he gets some slight rubbing once every rotation. Since he has had the bike for 12 years, not 5 yeras as I had thought, and was riding a front brake that was basically metal on metal for who knows how long (how he kept stopping I have no idea) I recommended that he get a new rotor.

I think you have that backwards. Counterintuitively, the inboard space (rotor to fixed pad) is supposed to be wider than the outboard space (rotor to moving pad.) Also, it shouldn't be necessary to touch the caliper mounting bolts when you replace the pads. You just back off the adjuster knobs, pull out the old pads, feed the new pads into the brake, then use the adjuster knobs to restore those 2/3-1/3 gaps (making both as small as possible without rubbing) after you've re-installed the wheel. The business about pinching the rotor between the pads applies when you are installing the caliper, to get it aligned parallel (so the pads wear evenly) and laterally (so the gapping is right.)

conspiratemus1: You are probably right about the 1/3 2/3 spacing--I was doing the post from memory, and it ain't what it used to be! As far as the mounting bolts, it sounded to me like the OP had to take the caliper off to fix it. If not, my bad.

This is what I did. twice as much space between interior fixed pad and rotor as between exterior pad.