I'm afraid you'd be better served summoning the rules lawyers for this one. Letting it remove encumbrance would open an exploit; OTOH it's currently contradicting the spirit of free action. If I were DM'ing I'd allow free action to overcome encumbrance but pile up the fatigue penalties faster to offset the advantage. I don't think anything is going to change for the game, though.
Encumbrance is a special case; it's not affected by Free Action because it has more to do with your ability to carry things than it has to do with your ability to move. PnP rules don't let Free Action (or similar effects) make you immune to encumbrance, although from what I recall the PnP rules say so more or less explicitly.
Psst. @Samus Come 'ere. I gots a secret! Spiders Bane grants a very rare and valuable special form of free action. This special free action protects from negative movement modifiers like hold and slow while actually enabling positive movement modifiers like haste. The only other item I know of that grants this is Keldorn's armor.
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