To be foiled is to be prevented in succeeding, so in this case, Smaug's plan to destroy a town is unsuccessful. I don't know for certain because I haven't read the book, but the following sentence suggests that the town is inside a lake, so Smaug wasn't able to pass through the water.

Often times being foiled means being fooled or tricked.

To Prevent Success - In common conversation, to be foiled means to be frustrated or halted in an endeavour. It is almost always used when a plan - usually a sneaky or corrupt one - is defeated by an unexpected obstacle or person. Example: "The bank robbers were foiled by a silent alarm." However, as you rightly point out, the fact of his prey being on an island shouldn't have foiled the dragon. Shouldn't he be able to simply fly over the water to his target? Anyway, keep up the reading. It is a great way to acquire new vocabulary and I'm sure you won't forget foiled, even though it wasn't really used very well in the book. Think of the cartoon villain in 'Dastardly and Muttley' shouting, "Curses! Foiled again!"