This page contains notes on parameters for the selenium RC server.
The documentation for this parameter says "-timeout: specifies the number of seconds that the server will wait for the browser to respond to the previous command, or for the client driver to issue a new request.". This can be taken to indicate that it is a way to set the default timeout for individual selenese commands during a run. I.e. that it is passed to the runner executing the commands.
If you look through the source code and experiment with it, you will find that in fact it specifies a timeout which applies to the run as a whole. It defaults to 30 minutes which should be more than enough time to run a complete selenium test. If you set it to 30 seconds (thinking of it as a selenese command max timeout) then you will find your selenium tests being suddenly aborted for no apparent reason. Also note that if your test exceeds this timeout and is aborted by the test runner then the log of the test will be lost.