Settlement free peering only happens if the traffic is balanced. In the case of Level3 and Verizon, it's not, hence Verizon's point (and apparently it was Level3's point when dealing with Cogent) is that the settlement free peering is not appropriate for such lop sided traffic and Level 3 needs to pay via alternative arrangement with Verizon.
It happens when it's mutually beneficial, regardless of whether the traffic is balanced. I have (free) peering w/ a few networks that are wildly off-balanced (on the order of 5:1 at times) simply because "free" is still cheaper than what I'd pay to send it to them over another (paid) transit link.
