I have cousins who have a sort of similar situation to deal with. No one died in this family, but when the mom was preg with #2 she had horrible health problems and had to spend alot of time in the hospital. The 3 yo dd spend most of her time at the grandparents' house where they 'gave in' to her every whim. It is now 2 years later. The second dd was born healthy, the mom is fine, but they feel they are still dealing with the consequences of having their first child poorly parented by the grandparents for 6 months.
IMO children crave stability and constance. Kids, especially when they become toddlers, begin to see their own power and abilities. But they still want someone to take care of them and keep them from harm. They may be afraid of their own power when no one reigns them in, because then they feel their own ability to create chaos.
It sounds like your friend knows all this, but her family does not. Perhaps a family visit to a therapist would be good. Someone who specializes in children and/or grief counceling. Everyone needs to be on the same page with this child.