I am not an attorney, but I assume the license is bound to the machine. If he creates the virtual disk, installs Linux on the same machine, and virtualizes the Windows on the new Linux installation (still on the same machine), there should be no problems.
If they moves machines, then yes, there is legal area to sue. However, Microsoft will not come after someone because they took a legal license and virtualized it. That's just not going to happen realistically. Knock on wood.
However, there may be a way to get an upgrade license to work as a fresh install. It may be worth your time investigating, and I may know, somehow, that it is possible.
Best of luck!
Install the trial. That is the only legal way to run Windows within a virtual machine without purchasing it. You would need to reinstall the operating system every 180 days. – Ramhound – 2011-06-02T12:56:41.270
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@Ramhound - 180 days is for the server editions. Only Win 7 Enterprise is available in the Win 7 client editions as a 90 day trial. You cannot re-install after the 90 day trial; that is also a violation of the terms of use. You also must meet eligibility requirements as explained http://technet.microsoft.com/en-us/evalcenter/ee388361
– P.Brian.Mackey – 2011-06-02T13:05:29.067Dual Boot is an option if you want to run native linux, or wubi if you'd like Ubuntu is the easiest way ;) – robx – 2011-06-02T20:32:29.157