Thanks for the great story!
I had similar incident during my last patrol, west coast of Scotland near Loche Ewe (sp?). I had used two torpedoes on C2 and surfaced to finish it with deck gun and then dive before planes come, this was March 1940, so I thought that I could do that before some hurricanes can reach us.
And like you, my watch officer shouts that enemy ship is engaging us, so I scanned the horizon seeing nothing, then I thought that the C2 was armed but no.
Nothing more happened, no splashes to indicating warship firing at us, so I just thought that poor man has spend too much time on patrols. Soon C2 is sinking and
then I spot Elco, just a few hundred meters away! I decide to fight, gun crew mans the deck gun and I use the flak gun. Elco comes very close, 100 meters or closer, and we are both firing like hell. After two hits from deck gun and I guess some hits from my flak, Elco goes down. No damage to my VIIB, she just need some new paint.
I learn that you better listen your watch officer.