It has the 42RLE transmission. It is a nightmare and should never have been put into vehicles. The 40-45mph issue at low RPM is notorious a bad spot for that transmission. I have the 42RLE in my LJ and want to replace it.
It sounds like the transmission fluid is contaminated with water. The entire pan will have to be pulled, since there is no drain plug, to clean it out with a new filter, put back together, and refilled. Unfortunately if this is the case and he has been driving it expect to save up for a replacement transmission in the future.
I am not entirely sure how the transfer case linkage works on the 2005 Liberty. If it is like other models then the adjuster screw could have slipped which is easy to readjust.