This comes down to the wording

"All upgrades are granted on a space-available basis, as determined at the time of check-in. Upgrades are subject to availability and identified by each hotel."

This leaves the hotel to "identify" if the upgrade is available and that means the hotel can simply have a pool of rooms it's prepared to upgrade to, and a pool of rooms that it "identifies" will not be made available to unpaid upgrades. All within the letter of the law, if not necessarily the spirit!