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I don't know what the issue is exactly, but I found a work around that I am happy to use. While reading about the App_Code folder (http://msdn.microsoft.com/en-us/library/t990ks23.aspx), I tried their suggestion and made sub folders, one for my webservice, and one for the datasets. Putting the webservice in a seperate folder seems to have stopped the issue, and allows the update command to work again.
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