I just got the Freetextbox to work with the Atlas UpdatePanel perfectly.
First of all I'm using the Beta 2 version of Atlas (now ASP Ajax I guess), so I don't know if it will work the same with Beta 1.
Anyway, all I did was place the following code to turn off the security validation. For some reason that seems to cause the 500 unknown error when you place the FreeTextBox inside the UpdatePanel.
ValidateRequest
="False"