OK, a little bit of chemistry:
The lithium in a battery is primarily going to be elemental lithium (Li metal atoms, whether or not they are touching each other to make an actual macroscopically-observable "piece" of lithium) when the battery is charged up. Discharging takes away an electron from those atoms to form lithium ions (Li+), with a release of energy. This energy is hopefully seen as Watts, when the electrons in the circuit move from one end to the other, turning your motor, etc. Charging reconverts the Li+ back to Li, giving you your energy back for the next run.
As long as the two sides if the battery cell are where they are supposed to be and are separated by an appropriate membrane (one that will not decompose), everything is fine. The problem comes when the cell walls or the cell membrane are breached. If the cell walls are breached, the Li atoms will react with oxygen or water vapor in the air (or liquid water) as they ooze out with the electrolyte, fizzing, heating things up a bit, and producing a caustic crud where the insides have escaped the battery. In extreme cases, the hydrogen gas produced could also produce a hazard, if trapped inside the battery pack (or the shrink-wrap) and a spark occurs from somewhere. This last part is not too likely, as the Li generally escapes the cell slowly.
If the membrane separating the two half-cells is breached, that's another matter. This can easily lead to an internal short-circuit of the battery since the electrolyte is conductive, and a LOT of energy (essentially all the energy that the battery has stored) can be released in a very short time within a very small volume. Now, you have an extreme amount of heat with nothing to do but catch any flammable material inside on fire, damaging inside and outside compartments further, leading to more heat, possibly spreading damage to the next cell over, causing it to catch on fire, and so forth.
This is what happened to the Sony computer batteries that caught on fire and made the national news - when a Li battery is recharged, the Li atoms don't always reform exactly where they came from and small needles, called dendrites, form. Sometimes these dendrites actually grow long enough to pierce the membrane separating the half-cells, and if this happens enough, Boom. That is one big reason why batteries cannot be charged too awful fast, fast charging leads to more dendrite growth, although some dendrite growth takes place every time the batteries are charged. This is also one reason why there is a lot of research going into electrodes using things like carbon nanotubes to isolate the individual Li atoms, so dendrite growth can be prevented, but not separate them too far from each other, or you lose energy density.
Cameron