|I am wondering how you came to the conclusion that the win 7 is illegal.|
Being a used laptop the original owner may have reformatted but never activated it.
Yes you can use the xp disk but you will need to get the drivers that are compatible with xp and the hardware on the laptop.
You do realize that a google search for win 7 32 bit or 64 bit can yield a site to download it and the coa on the laptop will work.
I am betting the OS is legal and there could very well be a restore option.