Rebuilding of the house and regrading the backyard
I would recommend the following:
1. talk with you neighbor and raise your concerns. ask if they plan on weeps holes and will the top of the retaining wall actually be higher than the finish grade on their side of the wall. you may have to remind them their post-construction run-off cannot exceed the pre-construction conditions. typically a retaining wall that high (depends of your building code) requires it be designed by a professional engineer. their engineer should be aware to address the run-off issue.
2. inquire with the local building department about your concerns. if they say there is nothing they can do or regulate about it ....
3. find a local civil engineer and discuss the issues with them. they would know what your local regulations are in regards to storm water run-off. you may have to spend money hiring them, but the flood you prevent may be more than worth the cost ....
4. check and see if there is a local board of appeals where you can appeal the proposed construction. I can only speak about board of appeals in my area, but they are normally established locally to address such concerns. Again it would depend on your location and the authority of the board.
I have typically found that #1 usually will take care of issues, unless you don't get along with your neighbor. there is when the other items must come into play.
Not sure if this well help you, but at least it should help to point you in the right direction. Again items such as them tend to have a very local flavor, so the suggestions I have given you may or may not apply to your local jurisdiction.
Good luck and post back with the outcome please.
"You get what you pay for, and sometimes free costs more!"