Vmware can do this.
the vmware converter can convert a running windows desktop / Server to a Virtual Machine. I think it can do Linux P2V as well in the enterprise product. The enterprise product can also go back the other way, converting a Virtual Machine to a Physical Machine.
THIS wiould be an excellent Disaster Recovery / Business Continuity option to have in your bag of tricks.
You can download vmware desktop / vmware server / and vmware converter for free..
(at least they were all free the last time I looked)
Physical to Virtual
Virtual to Physical
I don't see why it would be illegal provided you have licensing for each virtual machine OS you are running.. MS is in the business of selling licenses after all, and they would be just as happy to sell you 10 licenses to run windows physincally as well as virtually.. it's no difference to them, provided you pay up.
Wikipedia Physical to Virtual
You can also whip out a Google search for 'V2P' and get a number of hits for other products and third party tools.