Where do you see "Erase Free Space" being checked?
The only place I see that is in Disk Utility, and it's a button -- not a checkbox. If you did indeed click that button and allow Disk Utility to erase the free space on your hard drive, then yes, the files and the data are pretty much gone for good.
An easy way to alleviate the problem is to simply restore the user accounts from the backups that you regularly run.