Your story sounds like a normal trial flight and it's very purpose is to give the student an impression what it's like and whether it's worth spending money on doing a PPL. If you needed a medical first, then nobody would do trial flights.
It's up to the instructor to judge how much control he can let the student have, and this is indeed a potential risk for trial flights. Another point for the R22 is that a student should receive awareness training prior to manipulating the controls according to SFAR 73.
No emergency procedures with passengers is the rule. And I don't think it's a good idea to do a trial flight with passengers in the back in any case.