Ask yourself this question:
1) Is this model/background/character/game asset I'm working with originally in Final Fantasy 7?
If yes; then go about what you are doing.
If no; then please adjust what you are doing.
The reason for the rule is this. SquareEnix has something called "goodwill", which is the perceived value of their intellectual property. (Like how much their copyright is worth in terms of cash.) Putting in characters that don't belong like Sonic, or tuning Chocobos into motorcycles, or throwing in Darth Vader for Sephy damages SquareEnix's goodwill. This makes the perceived value of FF7 go down, and costs them real money on their balance sheets! This is why 99.999% of the C&D letters go out. Here's the thing about breaking goodwill. You can have A LEGAL COPY OF THE GAME and simply modifying could cause damage to goodwill. The original FF7 PC did not have an End User License Agreement (EULA), you you think you are in the clear. You are not!
Why do things like Overclocked music mixes get a pass? It's not because they don't charge for the CD. It's because Square perceives that such fan art does not damage their goodwill. Notice copyright doesn't even enter the argument. However, things like Chrono Resurrection DOES damage their goodwill. It makes their original work look like it has less value than someone else's.
Does this mean putting in ANY mod can damage goodwill? The answer is a wholehearted YES! When I say "SquareEnix has given a pass" that does not mean "SquareEnix has given permission". It Meas SquareEnix, for reason unknown has decided not to start legal proceedings. Maybe they don't know it exists, or maybe they are turning a blind eye. I have no idea.
So Enjoy that you can play FF7 in 1600x1200. Enjoy that you an inject higher quality models in. Just don't push it, because all it takes is one person to screw it up for the rest of us.