Client has asked for Cydia Application.

Can unity be legally used to create applications for use in the Cydia App store for iOS devices?

Unity could be used as it creates valid iOS applications.

Question is if you want to be banned lifetime from the appstore for smarty panting as apple will handle any cydia seller with full strength from what I've heard so far.

To clarify skovacs1' comment: Unity Tech should be able to tell you whether there's anything in THEIR license that prohibits it. I don't think there is. They won't be able to comment on whether Cydia's store itself is illegal.

A bigger concern is whether Apple's developer agreement prohibits it. According to the EFF, it did, as of March 2010. Clearly that hasn't stopped other developers from putting rejected apps on Cydia's store, but although Apple seems not to have dropped the hammer on anyone yet, they may try one day. Enforced or not, it seems like you'd be in violation of that agreement.

Things may be a little different if your client has an enterprise agreement with Apple. I'm speculating here, but the document the EFF posted says all distribution goes through the App Store. This is clearly not true for direct distribution of enterprise apps. So either the developer agreement overlooked that case, or there is a separate enterprise developer agreement that loosens some of the strings. I doubt it opens the door much, but a lawyer might be able to make something of it.

Putting myself in your shoes, here's what I'd recommend. If you are developing on behalf of your client (in their employ?) on their developer license, and they have a lawyer who can comment intelligently on all this, and you can somehow ensure that you will not be liable for your client's transgressions should they be found to have violated the agreement (this may require your own lawyer to establish!) then I think you are okay. But I doubt you or they have a lawyer, otherwise you wouldn't be posting this question. So personally, I'd pass.

(I think it's unlikely that Apple will take overt action against Cydia apps or their developers, unless that market grows significantly. But that wasn't your question.)

Disclaimer: I am not a lawyer, nor do I play one on TV.