Out of curiosity... if this is a bug in Lion, then why does it work in XBMC? I can get Dolby Digital in that application just fine and I haven't even had to update it.
I'm not trying to be a PITA, I'm just genuinely curious.
With 1.1.11 on Snow Leopard, I lost the option for encoded output for my M-Audio Transit, so I rolled back to 1.1.10.1 which cured it. Now that I have updated to Lion, I cannot get any optical output to work at all.
I can also confirm that as of 1.1.11, my M-Audio Transit no longer has an option for "Encoded Output". It's simply gone, so there's no way to get surround. Rolling back to 1.1.10.1 fixes the problem.