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ok, legality first. well modding voids all warranties as you can guess. is it legal? the mod chip itself: yes. the bios you must flash onto the chip: not really (lots of gray and black area here). if you search for mod chips you will usually find that they "do not come flashed".
if you do happen to flash it, there are ways to upgrade the hard drive (i have seen someplaces that sell xboxes for $400+ that have a mod chip installed as well as a 120 or 160 gig hard drive). i believe you can put the games on the hard drive much like if you would store a cd image on a computer. if you try to go onto xbox live with a mod chip, you will get banned from xbox live (even if you take out the mod chip or try on a different system). to get around this they make mod chips that can turn on and off. the downside is that you can not play backups or hard-drive-stored games on xbox live. i believe the xbox hard drive is IDE or easily swapable with an IDE (maybe a connector, i dont know). with a mod chip you can also use the xbox to run different "dashboards" for playing mp3s or videos directly from the hard drive. you can also install linux on the xbox.
once again, the mod chip is legal, flashing it to play backups, imports, and hard-drive-stored games, installing a new dashboard, or installing linux is in the gray to black area (meaning it may be "technically legal" or "technically illegal" or straight up illegal.
someone else may be able to clarify or correct me on any of this
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