This is how it normally happens.... even on redemption stays the no-show will normally be cash. Rather easy to avoid though, cancel in time or don't book with points if you don't know if you will make it.
On the legality I'm not sure. Seems excessive, but I doubt there will be many cases where people ended up paying the full amount.
But the biggest problem I have with this is that there is no way of knowing what the cancellation policy is because you never get the full details in your confirmation mail, nor are they easy to find anywhere else (if at all).